The Wall Street Crisis: What Does It All Mean?

So, clearly, the shit is still going down. Lehman and Merrill are effectively dead, AIG is in intensive care, being worked on by a team of doctors with cheap, lousy instruments, people on CNBC have been screaming at each other for days on end, and no one really seems to know what’s going to happen or what it all means. What everyone does seem to agree on, however, is that (a) it’s going to get a lot worse before it gets better, and (b) after the smoke clears, we’ll be looking at a changed landscape. And though it has been burned and battered, new and interesting things may grow in it, like morel mushrooms in the forest after afire.

First of all, the Fed’s decision to not bail out Lehman Brothers is being taken as a good sign (although everyone’s kinda wondering why they thought Bear Stearns was different). Like most people, the Times’ Joe Nocera thinks this will ultimately normalize the market: Without the government holding out a safety net for them, big banks will have to really account for their failures, and subsequently, borrowers will have to account for themselves and not take out big crazy loans for McMansions, and Cribs will from now on feature only truly rich people, which is how it should be. Okay, he didn’t quite make that last point, butstill.

Ultimately, Fortune’s Shawn Tully thinks, the demise of Bear Stearns, Lehman Brothers, and Merrill Lynch signifies the demise of Wall Street’s Wall Street: Business models that have been overly dependent on macroeconomic luck and which “grossly overcompensated employees for being in the right place at the right time” are outmoded, he says, while “a diversified, universal banking model,” i.e. commercial banks, is the wave of thefuture.

We shouldn’t expect even Morgan Stanley and Goldman Sachs to remain in their current incarnations, he says. “The best bet is that Morgan Stanley will eventually be absorbed by a big bank that will reduce leverage, shrink pay scales, fund assets with deposits and impose strict risk controls … Goldman, on the other hand, has the financial strength to move in the other direction and buy abank.”

These same cultural changes will reverberate globally: According to the Telegraph’s Tracey Corrigan, London sprouted a number of mini–Gordon Gekkos since Goldman, Merrill, and Lehman built up their presence there in the eighties and nineties, bringing with them “a bonus culture that encouraged traders to focus on short-term profits,” and those folks will ultimately have learned a important lesson. “You can’t pay chief executives billions of dollars if the taxpayer is to pick up the bill when things go wrong,” she says. “Painful as the crisis may be, de facto nationalisation of financial services is hardly the answer.” Of course, this lesson, while valuable, is not so pleasant tolearn.

Michael Lewis takes a look at a list of Lehman’s biggest losers — its list of uninsured creditors, which is dominated by Asian financial institutions — and concludes that the greatest loss will be moneyed Asia’s loss of faith in American institutions. “For 25 years Asian financial firms have been amazingly indulgent of U.S. investment bankers,” he says. “What do you think they’re saying about them — and us —now?”

Good point. Treasury Secretary Hank Paulson said yesterday that he pretty much expected this whole thing could blow over in “months, as opposed to years.” We suspect that after all this, it’s going to take a bit longer to restore full confidence — and that New York is going to have to fight hard to retain the title of financial capital of theworld.